(...) Keynes's remarkable book, How to Pay for the War began as a lecture delivered on October 20, 1939, before the Marshall Society, the underground economics club at Cambridge. After he had discussed his ideas with a number of government officials, Keynes published a revised version of the proposals as two articles in The Times, on November 14 and 15.[81] To Hayek's delight, Keynes concurred that both inflation and rationing schemes (Keynes called the latter a "pseudo-remedy"[82]) should if at all possible be avoided during mobilization. Another possible strategy was to raise taxes. Keynes pointed out that if this alternative were chosen, the tax would have to extend to the working classes, for two reasons: First, the amounted needed were so large that a tax on the rich would not generate sufficient funds to finance the war; second, a tax on the rich would not sufficiently reduce current expenditure, so it would not help with the problem of excess demand for consumption goods.

In order to avoid the inflationary outcome, then, the present consumption levels of the working classes would have to be reduced. In an attempt to soften this unpopular but inevitable truth, Keynes came up with the novel idea of a 'deferred pay' or 'compulsory savings' provision.[83]

A (progressively increasing) percentage of all income groups above some minimum level would be paid to the government, some of it in the form of taxes, the rest in the form of compulsory savings.

The latter amount would be credited to each individual's account at his Post Office Savings Bank. This sum would earn interest of 2~2.5%, but the individual would be blocked from use of the fund until the war was over. Keynes envisioned that the funds would be unblocked in a series of installments and timed to counteract (in good Keynesian style) the postwar slump.

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Hayek responded swiftly to Keynes's proposal. In an article published about two weeks later in The Spectator magazine, Hayek praised Keynes's ideas as "ingenious".[84] His only disagreement was to question the wisdom of using the release of the deposits as a tool of counter-cyclical fiscal policy. In its stead Hayek proposed his own novel idea:

a capital levy on old wealth that would be used to create a giant holding company.

Those who had deferred their consumption during the war would receive, instead of a cash claim against the government, equity in the industrial capital of the country. Hayek's scheme was a perfect complement to Keynes's. The latter had figured out how to reduce consumption during the war, and the former how ultimately to pay for it. Hayek's plan would, in short, turn workers into stockholders.[85]

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Keynes's plan was not well received by the Labour Party, the left press, or the unions; he would characterize the initial reaction of the Labour leaders as "frivolous and unthinking".[86] In an attempt to placate them, Keynes modified his proposal. In the book version, now called How to Pay for the War and published in February 1940, Keynes added[:]

a family allowance of ￡13 per year per child, an 'iron ration', or minimum ration of consumption goods made available at a low fixed price,

and Hayek's capital levy provision.[87] Hayek's proposal was designed to meet his own ends, keeping the levy as a means of paying for the war, but using the receipts to finance his own preferred cash payments scheme.

Hayek points this out in his review of How to Pay for the War in the Economic Journal, also reprinted in chapter 7, this volume.[88]

[2] Some chapter of the book (by Hayek)

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( ... ... ) create really grave political danger. And it must seem doubtful whether such repayment in cash of the "forced savings", otherwise than by ordinary sinking-fund methods, should be contemplated at all. There might, however, be a strong case for a capital levy on old wealth, payable partly in shares of the industrial capital of the country, to create a trust fund, a kind of giant holding company, which would give the holders of the war savings, instead of a claim against the government, an equity in the industrial capital of the country. The ordinary objection to a capital levy, that it means using capital resources for current expenditure, would of course not hold in this case. Nor need the use of this technique increase the burden on the capitalists. It would merely avoid carrying indefinitely the burden of a deadweight debt in the budget and thus to some extent reduce future budget problems.

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(... ...)

5. Hayek's Review of How to Pay for the War [14]

(...) It can indeed be said that [Keynes's] scheme (...) was received with more that sympathetic interest by economists in this country. After Mr. Keynes had acknowledged that "in war we move back from the Age of Plenty to the Age of Scarcity"[16] and that "the Age of Scarcity has arrived before the whole available labour has been employed",[17] the difference which has so long separated him from the more 'orthodox' economists had disappeared and any contribution to the burning problem coming from him was certain of the closest attention. Even so, however, the unanimity with which his proposal was approved by economists and the fact that neither serious criticism of the basic idea nor a real alternative was offered are a remarkable tribute paid to the author by his colleagues. It is unfortunate that in the existing conditions this practical unanimity of the experts could not find adequate expression. With so large a proportion of the economists of the country in Government service, and thus prevented from publicly expressing opinions on questions of policy, it may not be out of place for the reviewer here to record his personal impression that, so far as the main outline of Mr. Keynes's proposal is concerned, this unanimity was almost complete.

Well known as the leading ideas of the proposal are by now, it may not be altogether unnecessary briefly to re-state the reasoning which leads to it in a way slightly different from that employed by Mr. Keynes. Excluding inflation as an instrument of deliberate financial policy, the amounts required for the finance of the war must be raised by taxation and genuine borrowing. To obtain them entirely from the rich is literally impossible. As Mr. Keynes shows, even if their incomes were levelled down to that of the lower middle class (more precisely to ￡500 a year), the result would provide only two-thirds of Mr. Keynes's modest estimate of Government requirements of five months agoㅡquite apart from the resulting "widespread breaches of existing contracts and commitments which would considerably reduce taxable income".[18] Even a flat reduction of all incomes to ￡250 a year would only just suffice to produce the approximately ￡1000 million of revenue for which Mr. Keynes was then seeking.[19] It is clear, therefore, that a substantial contribution must come not only from the income groups under ￡500 a year, but also from those under ￡250. To obtain this by taxation is regarded as politically impossible. Nor would it necessarily be equitable. While it is inevitable that the lower-income groups should make some contribution now, it is not necessary that they should sacrifice once and for all the part of their income they must at the moment give up. Hence the plan for "deferred pay". What it amounts to in effect is that the poorer classes should merely advance what cannot be raised now from the wealthier classes, the sums so advanced to be repaid out of continued higher taxation of the latter after the war. That the comparatively poor must make their contribution to the material costs of the war is not a matter on which we can choose. Whatever plan we adopt, it cannot be avoided. If we let matters drift, inflation will hit them even harder, and the poorest hardest of all. The only choice we have is whether or not the inevitable sacrifice of the poor shall at least give them a share in our future income.

In view of these considerations, it is somewhat surprising that the proposal has not been more enthusiastically received by the representatives of the working class. Here the explanation probably is that although fairly simple, and explained by Mr. Keynes with the lucidity of which he is capable as so few to others, the dilemma which we have to face is still to complicated to be easily grasped by the man in the street. More surprising, however, must appear the objections, raised from different quarters, against the compulsory character of the savings imposed by the scheme. They seem to overlook that the 'deferred pay' is a substitute for taxation which must bring in the sums required, even if it means a drastic reduction in standards of living, and that to leave this to the voluntary decisions of the individual is about as reasonable as to substitute voluntary contributions for taxation,[20] It seems that Mr. Keynes is unquestionably right when he writes that to say "We shall depend on the voluntary system" is another way of saying "We shall depend on inflation to the extent that is necessary".[21]

( ... ... )

(...) Mr. Keynes has incorporated in the present exposition of his plan the proposal of a capital levy as a means of repaying the "deferred pay" after the war, and he mentions that the reviews was the first to suggest it in this connection. What I wish to point out is that the purpose for which I proposed it was very different from that to which Mr. Keynes intends to put it. I was, and still am, afraid of the consequences of such large amounts suddenly (or even, as Mr. Keynes now proposes, in a series of installments) released in cash, and particularly so when the decision as to the time and form of this release is likely to become the subject of political agitation. I suggested, therefore, that,[:]

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in order to avoid cash repayments on a large scale, the holders of the blocked balances should be given equity titles in the productive capital of the country, and that the capital levy should be used to transfer an appropriate portion of these titles toa kind of giant holding company, who would in turn issue shares to the holders of the blocked balances.

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Mr. Keynes wants to use the capital levy to finance the cash repayment. His views about the desirability of such cash repayments as a means to combat a postwar depression, as well as my belief that they are undesirable, are both based on the assumption that in the conditions after the war the receivers will be likely to spend most of the money soon after they receive it. (...) there remains a fundamental difference with regard to the purpose of the capital levy. This difference ( ... ... )